The sweet smell of fresh-baked coffee cake drifts out their front door. Their tidy Mission Viejo townhome's bathroom is stocked with wholesome magazines like Good Housekeeping.

Megan can stay at home with their two young children because her husband, Costa Mesa firefighter Mike Ruhl, makes enough to support them. His base salary is $74,000, and overtime brought him to about $115,000 in 2011.

"It's all about being a dad and a husband," said Mike Ruhl, 26.

The city compensates Ruhl for risking his life while fighting fires, but the pay and benefits that allow him to provide for his family are illustrative of a different kind of blaze — a political one — engulfing Costa Mesa.

Public employees like Ruhl say the compensation they receive affords them middle-class lifestyles, while the reform-minded City Council majority sees those employees' salaries, benefits and retirement plans as impediments to the city's long-term fiscal stability.

Outsource as many government functions as possible, they say, and the city will save on employment costs accumulated over the past decade.

But organized labor supporters argue the city can efficiently serve residents and businesses, while maintaining job security for loyal public workers. Employees are joined by members of a grass-roots community group and the lone dissenter on the council. Many say the council majority exaggerated the fiscal crisis and may have even concocted a political ruse.

When a maintenance worker, faced with a layoff notice, committed suicide about a year and a half ago, the political fight clearly intensified. But the conflict's causes date back more than a decade, according to an extensive review of past budgets and interviews conducted by the Daily Pilot. Previous council decisions, a change in council leadership and the recession have brought Costa Mesa to an unprecedented political precipice that could reshape its local government.

Battle lines

The battle is being fought on at least three fronts: the courts, where city employees are suing to block the outsourcing plans; the campaign trail, where two opposing ideological slates are competing to either push forward or overturn drastic reform efforts; and the ballot box, where a proposed city charter could reduce union power.

Labor won a reprieve Friday when a panel of judges ruled an injunction prohibiting outsourcing to the private sector would remain in place temporarily.

As the debate unfolds, it is clear that the majority of council members want to slash employment costs. But their reasoning is another story. At first, they said the city was on the brink of insolvency and pension payments were skyrocketing. Now that the budget is balanced, they say the streets and sidewalks are crumbling, and they need to carve out repair funds.

Conservative members argue that those priorities are consistent: Long-term financial planning is critical for future generations, and old Goat Hill's infrastructure is deteriorating.

But veteran Councilwoman Wendy Leece, a Republican and the lone minority member on the council, and many city employees represented by union-like groups known as associations, contend these reasons are a thin cover. The true political agenda, their supporters say, is coming from the Orange County Republican Party and the council majority: to reduce local governments' payroll and benefits by outsourcing.

When Newport Beach officials were negotiating with employees, OCGOP Chairman Scott Baugh said salaries and retirement benefits are pushing cities to the brink.

"We have a crisis with public-employee pensions in this state," he said. "It's going to be a catastrophe."

It's not so dire, Leece and others say. Costa Mesa's pension outlook will improve once the economy fully recovers, tax revenue climbs, and pension debt is lessened by investment gains, they contend.

Both sides' arguments appear to be somewhat overblown, local government experts say. Costa Mesa, they conclude, needs substantive financial reforms to continue to provide services, but the problems may not be quite as immediate as those elected officials who are steering the council argue.

"I think it's an overstatement to say that the city was on the brink of disaster," said Tom Wood, a retired Anaheim city manager who reviewed Costa Mesa's situation at the Pilot's request, but "the status quo is not acceptable. And believing that cities can continue to operate without change is just not realistic."

How much needs to be done, and when, remains at the heart of the debate.

How did the city get here?

There appear to be two broad causes for the current economic situation: large spikes in employment costs approved by previous city councils; and a recessionary climate that reduced income, due to a decline in tax revenue. Both made it hard to cover commitments from more sunny times.

Past Costa Mesa council members made pivotal decisions that fueled a decade-long employment spending spree. Between the 1999-2000 fiscal year, and the peak in 2008-09, the total cost of salaries and benefits climbed 45%, in today's dollars, while the number of full-time employees went up by just 5%. Without adjusting for inflation, that cost rose 80%.

And the bulk of those employment funds went to police and firefighters, just as they do in many other cities. The bulk of the public fight, however, has involved non-public safety employees. City managers are currently said to be privately negotiating reforms with the firefighters.

For years, council members prioritized public safety spending while declining to raise taxes. Meanwhile, employee associations bargained hard and won provisions that guaranteed pay and benefit increases. Council members at the time said they were trying to pay competitively with other Orange County cities and, when times were good and tax revenue high, the system appeared sustainable in the long haul.

Yet when the recession hit and tax revenue plunged, employment costs were so high that the city was forced to spend more than $30 million in reserves — about a quarter of its annual $129 million operating budget. Today, the budget is $117 million.

Those decisions to rely on deficit spending, some in the council majority argue today, were simply "kicking the can down the road" to future politicians.

"We aren't paying for what has to be done in the city," said Mayor Pro Tem Jim Righeimer, who has led the reform effort. "What we're saying is, 'We'll just go ahead and operate the city as an employment agency.' "

But that is essentially what cities do, the other side contends: pay salaries to provide services. They see the recession — and the drop in tax revenue — as the main reason for the city's reserve spending.

"People up here have said that the previous council has blown through $30 million," Leece said at an April meeting. "That was reserve money, and we were thankful that we had it because people were not buying things at South Coast Plaza, and people were not buying cars. It was not malfeasance. It was not poor fiscal planning. It was a necessity."

In pre-recessionary times, council members were more than happy to agree to union negotiators' terms. Labor was able to repeal an agreement in 2004 that had prevented raises higher than the rate of economic growth.

In the past, salary hikes were capped by the so-called affordability provision, which limited growth based on Chapman University's annual economic forecast and employment data.

But as the labor market tightened, city leaders were hamstrung by the restriction.

They couldn't compete with their neighbors for certain positions, said Allan Roeder, who served as Costa Mesa's city manager from 1985 until 2011.

The City Council then essentially guaranteed rising salaries: They would either be at the average or median of surrounding cities or at the pace of economic growth, whichever was climbing faster at the time of contract talks.

The same generally applied to benefits. As surrounding cities approved the most generous pension plans, Costa Mesa followed suit. Also, in 2001, the state Legislature signed a bill that made city workers eligible for boosted pension packages.

"We were in a bind," Roeder said.

He partially blames the repeal of affordability provision for the climbing compensation.

"That was really unfortunate," he said. "Would it have changed where things were at today? No, I don't believe so. But I do think that the impact would have been substantially less had that policy remained in place."

Costa Mesa's compensation rose to compete with cities like Newport Beach, which had piles of property tax revenue to spend, and Santa Ana, which had a higher crime rate and offered good pay to lure police officers, Roeder said.

Infrastructure lagged

As Costa Mesa pumped more money into salaries and benefits, it relied on grants to fund most of its infrastructure projects. But as state and federal money dropped off some years, city leaders deferred the repair of streets, storm drains, parks and other community facilities.

On average, Costa Mesa spent less on streets, storm drains and landscaping on a per-capita basis than any other Orange County city between fiscal years 2000-01 and 2008-09, save for Aliso Viejo, according to state controller data compiled by Michael Coleman, the League of California Cities' financial consultant.

Costa Mesa also ranks low for parks and recreation spending.

City leaders saved more than $70 million in reserves before the recession, with the idea that money would always be there when they wanted to reinvest in infrastructure.

Roeder said he "pinched pennies too much at the expense of the bigger picture." And in a later interview, he clarified that he always strove to maintain public health and safety.

Still, Costa Mesa spent an average of nearly $13 million per year on capital projects over the 10 years ending in June 2009, much of it coming from gas and county sales taxes.

That has been enough to rehabilitate arterial streets like Harbor Boulevard, upgrade intersections, improve Fairview Park, restore wetlands and perform other projects large and small.

The city's streets, on average, are considered good by Orange County Transportation Authority standards, scoring slightly below those in Newport Beach.

While arterial roads are in great shape, Costa Mesa falls behind in its residential streets and alleys.

One reason the city doesn't spend more on those and other infrastructure maintenance is that the capital funding program is outdated, Roeder said.

During the same period as rising compensation, traditional revenue streams for capital projects were unreliable: The city was mostly built out, with fewer developers to pay fees; and the availability of state and federal grants was erratic, Roeder said.

Also, there generally aren't many grants available to pay for parks or storm drains — two areas that need reinvestment, he added.

A 2006 plan analyzing the city's flooded streets called for $17.6 million in storm drain repairs or improvements, to be spent over 20 years. Only about $700,000 has been spent since then, during a partially recessionary period.

The City Council considered raising fees on developers to help pay for those storm drain fixes in 2006, but only approved a slight increase, Roeder said.

In the long term, swelling pension obligations may make it increasingly difficult for the city to continue its current spending. By the 2016-17 fiscal year, the city could have to pay $19.5 million per year into its pension fund, according to city Finance Department estimates provided to the Pilot in August.

Those are up from $14.7 million budgeted in the 2011-12 fiscal year.

But the city's pension projections have been contentious. Union leaders point out that the figures assume employees won't pay into their pensions after the current contracts, even though many have agreed to pay since 2007. More employee contributions — a likely outcome of ongoing negotiations — would lower the city's required payments. These concessions, they say, will help stabilize the city's long-term finances.

Also, the trajectory is far less steep than the Finance Department projected last year, just before the city announced its outsourcing plans. On Feb. 8, 2011, Finance Director Bobby Young told the City Council during a study session that the city could have to pay nearly $27 million per year by fiscal 2015-16.

Righeimer said: "These are big, big jumps. This is really what stares me in the face ... That's why we're looking at this [thing] so serious right now."

During the meeting, Young pointed out another important caveat: The $27 million figure assumed the retirement fund's investments would perform worse than the California Public Employees' Retirement System (CalPERS) officially projected.

"It does get subjective, and I want to qualify it," Young said at the meeting. "This isn't gonna happen, but it is a possibility."

Nonetheless, the council voted on March 1 to issue layoff notices to more than 200 employees, and Righeimer said one of the main reasons for outsourcing was the $27-million projection.

Councilman Steve Mensinger, in a later interview, echoed Righeimer's sentiment.

"We're going to go down the same road as everybody else — toward bankruptcy," Mensinger said.

San Bernardino and Stockton are among the state's cities to recently pursue bankruptcy protections; both partially blamed their woes on payroll and retirement costs. The story was similar in Vallejo, the nation's largest city to go bankrupt.

The Costa Mesa pension projections were a prime example of how City Council majority members adjust figures to suit their needs, union officials say.

"They can move it around to make it look like anything they want," said Orange County Employees Assn. (OCEA) General Manager Nick Berardino. "And they have that decision-making power. They have the ability to subjectively move numbers."

There is no disputing Costa Mesa's historical trend: Annual pension costs rose steadily over the past decade, as City Council members promised generous retirement plans and investment returns proved unpredictable. The city's annual pension payments rose from $5.2 million in the 1999-2000 fiscal year to $14.7 million in the 2011-12 budget.

Union contracts approved by the council explain a portion of the jump. Some retirement plans let employees retire at age 50 with up to 90% of their annual pay, and in many contracts, the city agreed to pay the full amount of the workers' retirements—employees were not required to set aside any of their paychecks.

Some of that has changed.

In 2010, Costa Mesa employees agreed to increase their pension payments, amounting to $3.6 million in fiscal 2010-11.

The current City Council members, however, with the exception of Leece, have repeatedly slammed the 2010 agreements because they actually increased the retirement benefits for firefighters, and thus long-term costs, and because some employees' contributions expire before their contracts are up.

"Nobody would bargain like that in the business world," Righeimer said.

Increasing the firefighters' retirement incentives caused some of them to retire early, saving the city cash in the short term.

Newport-Mesa Unified school board Trustee Katrina Foley, a city councilwoman between 2004 and 2010, said that the council thought the trade-off for a more generous pension plan was worth it.

"It's what everyone else has in the county, anyway," she said. "It's not like it's unusual."

One of the intentions of these pension plans is to lure people like Ruhl, who calls the CMFD a "destination department."

The average Costa Mesa firefighter receives $78,768 per year in retirement, and the average police officer gets $72,367. Other employees pale in comparison, at $27,359.

"I think we have always tried to be as fair as we could to the employees," said state Assemblyman Allan Mansoor, a city councilman from 2002 to 2010. "And quite frankly, they were treated very well."

Mansoor, a Republican, and other city leaders went along with pay raises during good economic times, as sales tax from South Coast Plaza and Harbor Boulevard's car dealerships flowed in.

For the pension debt, Mansoor blames the unions and previous council members for approving some of the most generous pension plans, especially those for police and firefighters.

CalPERS declines

Another reason for the climbing pension costs is the retirement fund's declining investment returns. The city's pension fund is in a large investment pool managed by CalPERS. As with other investments, most local governments' assets lost much of their value during the recession.

That increased the amount the city must pay today, to make up the difference and ensure its employees will get pension checks in the future. The so-called unfunded liability — the amount for which the city is obligated to pay but has not yet set aside — is approximately $131 million.

That CalPERS estimate assumes investments will perform well during some of the years Costa Mesa is paying it off. A more stark number — the amount the city would have to pay today — is approximately $207 million.

It wasn't always this bleak. For the better part of the last decade, CalPERS investments grew with seemingly no end in sight, often more than the current 7.5% projected annual return, and governments had to pay less because of the investment successes. For the past 30 years, the system's average annual return was 9%.

In the early 2000s, many cities' pension funds were actually "super-funded," meaning there was more than enough money to cover the liabilities. Costa Mesa paid next to nothing those years.

"[The unfunded liability is] a number that caught people by surprise," city Finance Director Bobby Young said, as the city was climbing out of the recession in late 2011. "Not many people had seen it."

Council members certainly acted as if they didn't foresee the consequence. From the late '90s, to just before the recession, they approved the pay increases, improved retirement packages and increased specialty pay for learning new skills, without wringing significant concessions from employees.

One retirement perk allowed employees to inflate the ultimate figure CalPERS uses to calculate their pensions. The city's annual pension payment was counted toward the employees' total pay. For example, if an employee makes $100,000, but Costa Mesa covers his or her retirement contribution — say, $8,000 per year — then his or her final pension would be based on a $108,000 salary.

It wasn't until 2007, when Costa Mesa's annual pension costs had climbed to more than $14 million from just above $5 million at the beginning of the decade, that its city employees began paying toward their own retirement.

But those payments were temporary. In November of last year, the firefighters' contribution stopped three years ahead of the end of their contract. General employees are set to end in February, and police are scheduled to pay through February 2015.

Public safety costs

Spending on police officers and firefighters accounts for about 70% of the city's salaries and benefits.

Hiring the "best" firefighters and officers was the top priority for the City Council in the years following the attacks ofSeptember 11, 2001.

Cities statewide were competing for recruits and driving up the going rate — agencies generally try to pay median rates to comparable municipalities — in a tight labor market.

The city hired about 20 more police officers in the early 2000s, after graffiti and shootings stemming from gang activity increased.

The department established a gang task force, and council members told administrators to "do whatever we had to do" to bring on new officers and fill vacant positions, said Roeder, the former city manager.

"We were under a lot of community pressure, and a lot of council pressure, about increasing staffing in the Police Department," Roeder said. "People were very, very unhappy."

While some studies show that more officers do not necessarily translate to fewer crimes, the city saw dropping crime rates during most of the 2000s, as did the nation as a whole. Public perception improved. Then, after another spate of violence in 2006, the council added even more police officers.

Public safety employees weren't the only ones who did well. For engineers, plan checkers and other general city workers, the city spent 23% more for all of their salaries and benefits in the 2008-09 fiscal year, in today's dollars, than it did in 2000-01.

"We have bargained very hard, and we have done very well," Berardino, the OCEA general manager, said at a Concordia University symposium on pension reform.

OCEA represents some 200 of Costa Mesa's nonpublic safety workers.

One of them is Bruce Lindemann, a maintenance supervisor who started painting curbs and has worked for the city for 22 years. In 2011, his base salary was $87,000, and his compensation totaled $116,000, including the city's contribution toward his retirement and health benefits.

Unlike Ruhl, who has five years on the job and lives in South County, Lindemann was able to buy a Costa Mesa home in 1998, according to public records, when prices were much lower. He spends his free time surfing and boating. He has a Bayliner, an everyman's motorboat. It's a decent career that Lindemann says he will try to preserve, even if it means leaving Costa Mesa for a department elsewhere on the Pacific Coast.

No tax increases

Spending on employees isn't the only reason Costa Mesa was strapped during the recession. For decades, council members have been reluctant to ask voters to increase taxes, Roeder said, and instead would point to the ample sales tax receipts.

"The city has been overly reliant on sales tax for a long time," he said.

Then, in 2010, the city increased a tax on hotel stays — its first tax increase in 20 years, Roeder said.

"[Keeping taxes steady] is to be applauded, to a great degree," he said, "but you also have to look at what are the consequences of that. How much you can afford to reasonably do?"

Facing anemic sales tax revenue and a need to cut, Costa Mesa leaders were constrained by high employment costs. They couldn't make a substantial dent in the budget by simply pulling back on infrastructure spending. That inflexibility is now one of the fundamental arguments for restructuring government.

It also didn't help when Costa Mesa lost about $5 million overnight, when its investments in Lehman Brothers disappeared when the investment firm declared bankruptcy in 2008.

As the city burned through its general fund reserves, it had to borrow from other internal funds, like the one reserved for replacing old vehicles and other equipment.

City leaders cut back on park and building maintenance, moves also seen at other cities around the state.

General fund cash levels dropped during the three years Costa Mesa was running a deficit—in fiscal years 2007-08 through 2009-10. Some called it a cash crisis, but experts and city administrators say the city had viable options, such as short-term borrowing or using cash in other funds, in case of an emergency.

Administrators and council members waited to cut employment costs — the first furloughs were in 2009, a year after sales tax receipts began to drop — and used reserves to backfill the difference.

During the April 2009 council meeting when they approved the furloughs, Foley said, "My goal here tonight is to not eliminate one job. That is my goal."

While some on the right have criticized Foley, a Democrat, and the rest of the council of her era, Wood, the retired Anaheim city manager, said Costa Mesa's approach was sound.

The goal is to keep a steady level of services for residents and businesses, he said: "You don't cut [when] the first-year revenues are off."

Eventually, the city reduced its full-time staff from 610 employees to 480, using a combination of layoffs, early retirement incentives and leaving open positions vacant.

By the end of the 2010-11 fiscal year — four months after the council issued its layoff notices — its budget was balanced again.

Now, employees are challenging the pink slips in court, and the ideological battle in Costa Mesa is expected to continue.